Yeah, I have looked that up. And while that formula did end up getting 3 people a Nobel prize, I really don't like it.

Instead of going for something that looks fancy and is harder to actually implement, I prefer the use of Occam's razor in this instance.

Things that complicate your suggestion are things like believing you can predict market returns or that you can accurately assess the risk involved.

Compared to that, my way of picking stocks is very straightforward and does not need judgement calls in order to succeed as it relies on already-existing numbers and sees no need to forecast results or assess risk in order to produce better results and lower risk. It is simply built into it because the stocks chosen are, compared to the rest of the market, cheap for their actual performance.

Because of this, this system would not have been in many of those tech stocks as they went up or investing in them when the bubble burst either. Because this system relies on actual results that have already taken place, it is far more reliable than using numbers that are more subjective in nature.

Kombat: To have everyone even attempt to use it would require that they actually be willing to give it consideration first. That value investing has worked for decades and that most people still don't use it, and you use that as a reason to not use it just goes to show that people don't like to change and will use any excuse to not do so such as yours: Others are not, so I won't. If everyone uses that excuse, then would you expect anyone to change to something new that worked better? Of course not.

But at the same time you are expecting other people to be capable of doing something you aren't : trusting in something that is rather new in that it has only been proven effective in more recent history with our greater databases of stock data and superior computers that can make fast and accurate comparisons.

The more likely course an investor is going to take is going to take is to take advice from a well-known, successful investor. Example: Warren Buffett recommends using index funds. Did he make his fortune using index funds? No. But, despite people realizing that he didn't make his fortune that way, they will continue to take the advice of investing in index funds even though it is clear that this is not what made him a successful investor. It's really stupid, but there it is.

And when something comes along that does better than index funds, all people will do is point to the well-known investor that recommended this, but doesn't do it.. that or, for those more knowledgeable, point out that the majority of mutual funds do not beat indexes and that most active traders don't beat it either.

At the same time, they don't realize that the reason for this is that the traders didn't have a developed system that was stuck to and often the fund managers didn't either. Given different market conditions, some people in charge of mutual funds will switch from growth to value or the other way around (despite having the words Growth or Value in the fund name). Or they don't realize that an experiment was done where a set of stocks was pre-selected and given to investors for investment, but they couldn't beat even a simple portfolio that was managed by computer software. Too emotional and not enough discipline in selecting for their portfolios. Even though the computer was restricted to the very same stocks they were, they consistently did worse.

When you wonder why people seem to do better with indexes, it is rather simple.
1. People see indexing as investing in a ton of companies at once.
2. People see having their money invested as better than not having it invested.

This creates a situation where people are less likely to shuffle their money around, which means more discipline is being used.

Mr. Clinger, how do you define a value stock? How do you define a growth stock?

Minor nitpick: Warren Buffet didn't make his money by "value investing" either.

He bought entire companies, changed them, and improved their profitability. That's completely different from trying to identify undervalued companies, buying their stock, and sitting back and waiting for people to realize it was undervalued so you can sell and make a profit.

DH, you know I believe the market is efficient. If something gives a higher return, then it's because it was a higher risk. I don't believe there's any free lunch, and I don't believe anyone can consistently beat the market average.

He's already been asked that. He's not interested in a rational discussion about value investing. There will be a lot of arm waving about a book he found at half priced books and that you should read that.

OF course, you don't really appreciate the upside until you've felt the downside. Most importantly, you can't really gauge your tolerance for risk until you are playing on the field.

Meanwhile, some of you think a little year long experiment will actually prove something to the other party. At the end of the day, no one will be converted to the other side. Most surprising to me, however, is that the moderators allow this troll to pimp his "services." Sure, I could see if he wanted to talk about value investing methodology. But he doesn't, he's just here to try and turn a couple of cheap tricks. And, much like Rob Bennett (aka Hocus), destroying the board. As the old Biblical story goes, I'm washing my hands of this clown, and if anyone is swindled, that's on those that are in charge here.

Value investing, as I have previously posted, uses fundamental stock data most often in order to create a form of data that directly shows data that is directly comparable to other companies, often with an emphasis on how the total value of the company's stock is valued (although there are instances of when price is cut out entirely, such as in the case of EBITDA/EV). Although there are some value factors that are not compared in such a fashion, many are. Value investing uses these factors to find stocks that compare favorably against other companies by using the same metric for both companies and then selecting the company with the more favorable number. Most often, but not always, these numbers will involve the lowest numbers. Multi-factor models used in this way are concerned with combining favorable results in multiple areas in order to have a stronger indication of what stocks represent a good selection. The purpose of value investing is to identify stocks that, using fundamental stock data, identifies stocks as undervalued in comparison to other stocks.

Growth investing on the other hand promotes the idea that companies that either are growing above the average rate or have great growth potential are favorable investments and the idea is that as the company earns more, the stock will become worth more.

And certainly, while some investors still invest on pure growth, it has become more popular since the dot com crash for growth investors to use a hybrid approach and thus the reason for the phrase "growth at a reasonable price", which denotes a strategy for buying growth stocks with reasonable valuations. (The reason for this being that growth stocks that failed to live up to their expected growth potential would be far less likely to lose a major portion of their value if they were already more reasonably priced as compared to a growth stock that was extremely over-priced) - thus, even growth investors these days will be likely to include some form of value investing in order to lower the amount of risk involved.

Kombat, I believe the markets are only partially-efficient. For the markets to be totally efficient, that would require the buyers and sellers to be totally efficient. However, many different ways of looking at the market exist and numerous strategies for buying and selling exist as well. In order for the market to be totally efficient, every person would need to be equally educated about the stock market, equally knowledgeable about all that happens with each company, interpret the data the same way, without emotion and with total discipline. Perception would also have to be equivalent to reality.

The reality is that the dot com crash happened. People talked about the "new economy" and how earnings weren't necessary for a company's stock to do well in the stock market. The reality is that the perceptions of investors do not match with the reality of the stock market. People had the information that these companies were not generating earnings and despite this pushed their prices to unreasonable levels. At most, these markets are semi-efficient. Total efficiency does not exist in our stock market.

Right.

Until the market realized the stocks were overvalued, then the values crashed back down to where they belonged.

Because the market was efficient, and corrected the incorrect valuations. Which is exactly what I'm saying.

We can all look up on wikipedia what a value stock and growth stock is. Besides, most of us already know this. The question is, what are your metrics? You say you look at it objectively, but then you spew ambiguity when pressed.

Yeah. And that's what the securities market line demonstrates. Riskier stocks return more. I believe the markets are weakly efficient but I also believe it is extremely difficult for most of us to exploit the inefficiencies for profit. Individuals don't have access to the information they need and big funds are too massive to make moves without influencing the market and erasing the inefficiencies they are trying to exploit. Hedge funds were supposed to work in that niche but they have basically not been able to either. So even though I don't believe the market is as strongly efficient as you do, I also don't believe the inefficiencies can be effectively exploited over the long term. There have been a few people who have done a pretty good job of doing so over relatively long periods but they are very rare.

I tend to hold the view that the markets are strongly efficient over the long term (which explains why value stocks tend to outperform the market over the long term) but not "precisely" efficient (which helps to explain why value stocks can underperform the market at times, sometimes for very long periods).

I believe that this is the reason it's called a "random walk" by Malkiel. It's like a drunk that ultimately gets to where he's supposed to be going, but lurches from side to side in the process. I do agree with DH that it's difficult, if not impossible, to capitalize on such lurching about, consistently over the long term.

Far easier for me (i.e. less time- and labor-intensive) to just do what I've been doing, which is to use index funds covering the entire market, with a weighting toward value and small caps. I have other things I'd rather be doing, although I'll concede that they may not necessarily be "better" things.

Here's some ACTUAL performance data:

Beginning in 1996 we put exactly the same amount twice per month into Vanguard Total Stock Market Index and Vanguard Value funds (as well as a few other funds). This ended in about 2007 and the account has been sitting untouched since then. Since we put the same amount in each fund and there were never any transfers in or out, the one with the highest balance should be the best performer over that time period. Here are the results as of 12/31/12:

Vanguard Total Stock Market: $20763.26
Vanguard Value: $19525.24

So it looks like TSM has done better over the 16 year period. Even though I completely agree that value stocks SHOULD perform better, they have not. Those results include all fees. This is from a tax deferred account so there are no tax impacts. But a perusal of my statements shows that the value fund has paid out substantially more dividends and capital gains distributions over the years so if we included tax effects in a taxable account the TSM fund would look even better.

I would note that the difference is small enough that, without actually doing the calculations, I suspect that the value fund may have done slightly better before fees. But that hardly matters since we can't invest before fees.

DH,

Your results are unsurprising. There were considerable periods when value stocks underperformed both the S&P 500 and growth stocks. I believe Bernstein has mentioned periods of underperformance for as long as 10 years. This chart only goes to 2000, but you can see huge underperformance of value stocks during the first few years of your investing period. During the go-go years of the market's irrational exuberance, growth stocks (and tech in particular) were the darlings of the investment world.

What would really be interesting to see is what your results would be in 4 years, when the investment period would cover at least 20 years.

Perhaps I will report back on that. I have no immediate plans to move this money away from Vanguard or make any allocation changes.

Bichon Frise, I have said more than once what my metrics are. You just don't listen when I say them. I use P/E, P/FCF, P/S, and P/B as the main determinants in selecting my stocks. Each of these ratios is used as part of value investing. The important part is how they compare against other stocks, not the absolute value of any of the ratios involved.

Interesting topic.. I partially agree with you Mathew however I dont understand why you would only consider the US to invest in. A value investor invests where it is most attractive to invest.

1 year returns count for nothing